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TMI Blog2018 (4) TMI 878X X X X Extracts X X X X X X X X Extracts X X X X ..... and circumstances of case and in law by passing an order for Assessment Year 2009-10 which is bad-in-law. 2. The Ld. CIT(A) has grossly erred on facts and in law in partially confirming the adjustment of ₹ 35,919,343/- computed by the learned Assessing Officer ( Ld. AO ) in the assessment order passed under section 143(3) of the Income-tax Act, 1961 ( the Act ), by holding that the international related party transaction of the Appellant with respect to the provision of software development services do not satisfy the arm s length principle as envisaged under the Act. In doing so the Ld. CIT(A) has erred: 2.1 by not appreciating the fact that none of the conditions set out in section 92C(3) of the Act are satisfied in the present case; 2.2 by disregarding the economic analysis conducted by the Appellant to determine the Arm s Length price ( ALP ) of the international transaction pertaining to software development services in compliance with section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 ( Rules ) in the Transfer Pricing ( TP ) documentation; 2.3 by disregarding multiple year/prior years data as used by the Appellant in the TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mparable companies that are full- fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the Appellant on account of this fact; and 2.10 by committing a number of factual /computational errors in selection/ rejection of proposed comparables and/ or in the operating profit margins of the comparables; 2.11 by disregarding judicial pronouncements in India while computing an adjustment to the transfer price of the international transaction entered into by the Appellant. 2.12 The Ld. CIT(A)/ AO has erred by not limiting the amount of adjustment to the lower end of the arithmetic mean as envisaged under second proviso to section 92C sub section 2 of the Act. 2.13 by ignoring the fact that the Appellant is entitled to tax holiday under section 10A of the Act on its profits and therefore would not have any untoward motive of deriving a tax advantage by manipulating transfer prices of its international transactions; 3. That the learned AO, on the facts and in the circumstances of the case and in law, has erred in 4. That given the facts and circumstances of the case and in law, the Ld. CIT(A)/ AO has grossly erred in confirming the ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of consideration for the same does not amount to sale or export. e) The purpose of the determination of Arm's Length Price, under the Transfer Pricing Regulations, of a transaction between the Branch Office and Head Office is to prevent Base Erosion and bring to tax in India profits of the foreign entity attributable to the Functions Performed, Assets Utilized and Risks Assumed through the Branch Office in India. The Transfer Pricing exercise does not obliterate the fundamental fact that the Branch Office and the Head Office together constitute a single entity. 1.3 Whether on the facts and in the circumstances of the case, the Ld CIT(A) has erred in not appreciating the fact that the true intention of legislature behind enshrining the deduction u/s 10A, as evident from subsection (3) thereof, was to bring in precious foreign exchange, which is not fulfilled in the present case, because the assessee being a foreign company is not retaining the sale proceeds in India except the tax on a fraction of the profit which is attributable to Indian branch of the foreign company. 1.4 Whether on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appreciating the fact that the provisions of section 80IA(10) have a specific purpose, namely, manipulation in the quantum of deduction by the expedient of arranging a course of business between the assessee carrying on the eligible business and any other person closely-connected with the assessee. However, there being no two separate assessees in this case, this provision in also not applicable. 1.8 Whether the Ld. CIT(A) has erred in not appreciating the fact that in Section 10A of the Act there is no provision akin to explanation 2 to Section 80HHC and therefore there is no concept of deemed export under the provisions of Section 10A of the I.T. Act. 2. Whether on the facts and in circumstances of the case, the Ld. CIT(A) has erred in directing the Assessing Officer/Transfer Pricing Officer (AO/TPO) to exclude M/s Bodhtree Consulting Ltd from the list of comparables for the purpose of benchmarking the International Transaction and computation of Arm's Length Price in relation to software development services. 2.1 Whether the action of Ld. CIT(A) in excluding M/ s Bodhtree Consulting Ltd from the list of comparables solely on the basis of abnormally high pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pproval from the Reserve Bank of India (RBI) with the sole object of development and export of software. The branch office set up a Software Technology Park unit under the Software Technology Parks Scheme of the Government of India for establishing the unit therein per approval dated September 23, 1999. Since the date the branch was established, and also during the instant year, the business of the branch office was to develop and export of computer software to its head office in USA. Products delivered by Virage group consist of various software tools along with supporting files that contain design data for creating the requisite silicon IP (Memory or Logic elements). Since inception of India Branch Office in May 1999, the engineering site at India has been working on various following activities related to the IP products and platforms offered: * Software development in C, C++ and TCL/Tk on our Embedded-IT range of software tools. * Development of programs and files that constitute our Memory Compilers or Logic libraries. - EDA views in TCL/Tk programming language. - Programming files in appellant's proprietary format that describes the physical, f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as challenged exclusion of 6 comparables, whereas the Revenue has challenged exclusions of 3 comparables by the Ld. CIT(A). 5.1 Before adjudicating the transfer pricing issues, brief background of the addition is discussed below: (a) The assessee in its transfer pricing study reported value of the international transaction of provision of software development services at ₹ 16,55,40,226/-. For the purpose of benchmarking the transaction, the assessee carried out a search on databases and chose Transactional Net Margin Method (TNMM) as the most appropriate method and Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI). The assessee selected 16 companies as comparable and worked out average PLI of 11.64 percent, by using multiple year data as compared to PLI of the assessee of 7.53%. The margin of the assessee being in the +/- range of 5% as prescribed under section 92C(2) of the Act, the assessee concluded that the international transaction is at arm s length. The Ld. TPO observed that the assessee should have used current year data rather than multiple year data of comparables. The filter applied by the assessee was also not found appropriate by the L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f comparables (ii) verify corrected margin of FCS Software Solutions Ltd. and; (iii) include Akshay Software Technologies Ltd. and Quintegra Solutions Ltd. final set of comparables (d) The Ld. CIT(A) upheld the denial of working capital adjustment on the margin of comparable companies. The final set of comparables selected by the Ld. CIT(A) is reproduced as under: Sr. No. Name of Comparable Unadjusted OP/TC% 1. Cat Technologies Ltd. 34.43 2. Goldstone Technologies (Seg.) 10.28 3. Larsen and Toubro Infotech Ltd. 21.33 4. Mindtree Ltd. 27.36 5. Persistent Systems Ltd. 37.77 6. Tata Elxsi Ltd. (Seg.) 16.88 7. Thirdware Solutions Ltd. 37.27 8. FCS Software Solutions Ltd. 15. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m software development and consulting services and revenue from medical transcription is less than 10% of the total revenue, therefore, the company should be retained as comparable. iv. We have heard rival submissions and perused the relevant material on record. On perusal of the Schedule IX, of financial statement of the company for the year under consideration, which is available on page 36 of the Annual Report Compendium, we find that income from operation consist of following streams: Particulars For the year ended on 31.03.2009 (Rs.) 31.03.2008 (Rs.) SCHEDULE-9 Income from Operation Training Income 244,107 1,172,040 Software Development Consulting Services 84,939,375 48,395,187 Medical Transcription Receipts 8,374,194 10,633,128 93,557,676 60,200,354 2 v. It is seen from the above ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... td., has also earned Medical transcription receipts of ₹ 83.74 lac and Training income of ₹ 2.44 lac, both of which have been combined with the income from Software development and consulting services. One cannot ascertain with precision the contribution made by the income from Medical transcription and Training to the overall profitability of CAT Technologies Ltd., so that the other income may be segregated. As such, we fail to comprehend as to how the entity level comparison of this company with the assessee s 'Software development and maintenance services segment can be construed as valid. This company is, therefore, directed to be excluded from the list of comparables. vii. In view of the aforesaid discussion, the Ld. TPO/AO is directed to exclude this company from the list of the comparables. 2. Mind Tree Ltd. i. According to the Ld. TPO, the company is a service company engaged in providing services related to software development and thus it is one of the comparable. The Ld. TPO rejected the contention of the assessee of extraordinary event of acquisition during the year under consideration, on the ground that acquisition has not affected the o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect of extraordinary event of acquisition on the profitability of the company. He submitted that revenue from infrastructure management and tech support is only 3.4% of the total revenue breakdown and thus the company is predominantly software development service only. vi. We have heard the rival submissions and perused the relevant material on record. The Ld. counsel has sought exclusion of the company basically on two grounds. The first ground is extraordinary event and the second-ground is diversified functions. Regarding the extraordinary event, on page 121 of the Annual Report Compendium (page 24 of the Annual Report) it is mentioned as under: On December 17, 2007, MindTree Ltd. ('MindTree' or 'the Company') acquired 100% of the outstanding equity shares of TES PV Electronic Solutions Private Limited ('TES PV'), which was subsequently renamed as MindTree Technologies Private Limited (MTPL). In the current year, subsequent to the acquisition, the company, vide a scheme of amalgamation proposed to merge MTPL with itself. The approval from the High Court of Karnataka was received in January 2009 and the scheme was effective April 1, 2008. Consequ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al Report of the company, it is evident that operations of IT services have been claimed related to business segments of IT services and R D services. Thus in both the segments the function of the assessee is of software development only, which also get confirmed from the only revenue stream of income from software development. In such circumstances, the company is comparable at the entity level and thus there is no effect of unallocated expenses in segment reporting. In percentage breakup of service offerings, also services rendered are related to software development except in a small amount of 3.4% for infrastructure management and tech support, which is not significant. In absence of details of any revenue from other streams other than the software development, there is no valid ground for excluding this company from the set of comparables. Accordingly, we direct the Ld. TPO/AO, to retain this company as comparable. 3. Persistent System i. Before the Ld. TPO it was claimed that company derives income from sale of software services as well as sale of products and in absence of any segmental results, the company should be rejected. The Ld. TPO noted that company is predo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tc and thus cannot be compared at entity level. According to the Ld. TPO, the SEZ unit also exported software services and, thus, dominantly the company is in software development service and sale of license is only 2.3 crores out of total sales of ₹ 77.03 crores, which constitute 3% of total sales. The Ld. TPO also found the related party transactions (15.32% ) below the threshold of 25%, and thus included the company as comparable. The ld. CIT(A) confirmed the action of the Assessing Officer and retained the company as comparable. ii. Before us, the Learned counsel submitted that revenue of the company consist of sale of license and subscription along with software services and no separate segmental result of software services are available in Annual Report of the company and, therefore, it cannot be compared with assessee at entity level being functionally dissimilar. The Learned counsel also relied on the decision of the Tribunal in the case of Sun Life India service Centre private limited versus DCIT in IT No. 1489/Del/2014, wherein the company has been held to be non-comparable to an assessee providing contract software development services. iii. On the contrary, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce no distinguishing features of the functional profile of this company and the assessee for the current year vis-a-vis the preceding year have been brought to our notice, following the precedent, we order for the removal of this company from e list of comparables. vi. Thus, in view of non-availability of separate segment of software development services, the company is held to be functionality disimilar, and accordingly, the Learned TPO/AO is directed to exclude the company from set of comparables. 5. Tata Elexi Ltd. i. Before the Ld. TPO, the assessee submitted that company is engaged in non-comparable services, which included IT enabled and software product services and, therefore, the company needs to be rejected. According to the Ld. TPO, the services of product design, innovation design engineering, visual computing labs are sub segment of software development industry and, therefore, he selected the company as comparable. The Ld. CIT(A), affirmed the action of the Ld. TPO. ii. Before us, the Ld. counsel submitted that the company was excluded by the Tribunal in the case of the assessee for assessment year 2008-09 on the ground of functional dissimilarity an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e given. Under software development and service segment, services of product design, innovation designing engineering service and visual computing lab are reported. Under the visual computing labs following activities carried by the assessee are reported: Visual Computing Labs: VCL delivers 3D computer graphics, animation and special effects in the pre-production, production and post-production of content for the film, television, gaming and advertising industry. During the year, VCL successfully completed India's first full length fully animated commercial film, coproduced by two leading-Indian and overseasstudios. The film was released in 2008-09 amidst positive feedback for the quality of work produced, including nomination to the prestigious Visual Effects Society's Award for Outstanding Animation in an Animated Motion Picture . VCL is the first Indian studio to be nominated for such a prestigious award. During the year, VCL also commenced work on the next animated commercial film, again for a leading Indian studio. The film is scheduled for release in 2009-10. During the year, VCL continued to deliver high end special effects for several prest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .33%. iii. On the contrary, the Learned DR submitted that during the year under consideration there is no revenue from consulting service and only revenue shown is from software development services and product. The Learned DR referred to page 93 of the Compendium of the Annual Report and submitted that the revenue earned is from software development services in the field of financial, manufacturing and telecom and no revenue from sale of product is reported. The Learned counsel also submitted that expenses of the assessee are also related to software development activity and no product development expenses are debited under operating expenses. Accordingly, he submitted that the company can be safely presumed to be engaged in software development services only. 5.4 We have heard the rival submission and perused the relevant material on record. On perusal of profit and loss account available on page 74 of the Annual Report Compendium, the income has been shown from software development and products. Further, On perusal of page 93 of the Annual Report Compendium, we find that the entire activity of the company is related to software development in different like verticals finan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6.2 The Ld. DR submitted that the ld. CIT(A) has not given any basis or referred the Annual Report for concluding that there is 300% growth in the profit and volatility in the profit of the company. According to him, increase in profit in one year cannot be basis for excluding the company, if it is otherwise functionally similar to the assessee. 6.3 The Learned counsel of the assessee, on the other hand, filed pages No. 12 and 25 of the annual report of the company and submitted that the company has recognized its revenue from software development on the basis of software developed and billed to the clients and due to which expenditure seems to have been debited in respect of software development in progress but the corresponding revenue has not been credited and due to which there is a volatility in the profit of the company on year-to36 year basis. The Ld. counsel submitted a chart of fluctuating margin of the company is under: FY 2011- 12 FY 2010- 11 FY 2009- 10 FY 2008- 09 FY 2007- 08 FY 2006- 07 -10.87% 2.78% 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7.2 Before us, the Ld. DR submitted that page 40 of the Annual Report, the activity of the company during the year under consideration included computer software development and support services, computer software products and other information technology related services. He also referred to the copyrights of ₹ 2,71,75,655/- held by the company to show that company has several products which it customizes for the clients and thus the company is functionally dissimilar to the assessee at entity level. 7.3 On the contrary, the Ld. counsel referred to page 40 of the Annual Report and submitted that the reporting as stated by the Ld. DR is in respect of Quintegra solutions Ltd., UK and not in respect of Quintegra solutions Ltd, India. He referred to page 21 of the Annual Report and submitted that there is only one segment of software services and no revenue for any other streams and, thus, the company is functionally similar to the assessee. 7.4 We have heard the rival submission and perused the relevant material on record. It is evident that argument of the Ld. DR that the company is engaged in sale of software products or ITes services, is not based on correct facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... restored the issue of working capital adjustment to the file of the Learned TPO/AO. 9.2 The Ld. DR could not controvert this finding of the Tribunal and did not object to restoring the matter to the Learned TPO/AO. 9.3 We have heard the rival submission of the parties and perused the material on record particularly the order of the Tribunal in ITA No. 6918/Del/2014 in the case of the assessee for assessment year 2008-09. The relevant finding of the Tribunal on the issue of working capital adjustment in margin of comparables is reproduced as under: 9. Considering the submission advanced and the precedent relied upon in view of the above, we are of the view that it would be appropriate in the peculiar facts and circumstances restore the issue back to the TPO. While so restoring it is made clear that the onus for providing the relevant data warranting risk and capital adjustments if any in the comparables has to be provided by the assessee. The TPO thereafter considering the same shall pass a speaking order in accordance with law giving the assessee a reasonable opportunity of being heard in case any adverse conclusions are sought to be drawn. 9.4 Respectfully, foll ..... X X X X Extracts X X X X X X X X Extracts X X X X
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